Brussels cuts Eurozone inflation forecast

Brussels has lowered its forecast for inflation in the Eurozone for the second time this year, becoming the latest in a growing number of government institutions whose data raise the spectre of deflation in a region still struggling to emerge from four years of economic crisis.

According to the European Commission's forecasts issued on Monday morning, consumer prices in the Eurozone are expected to increase just 0.8 per cent this year and 1.2 per cent next year. The prediction for 2014 is a downgrade from the 1.0 per cent forecast less than three months ago and 1.5 per cent foreseen in November of last year.

Despite the troubling inflation picture, the data also showed the long-predicted recovery in the common currency area was holding. The Commission stuck with its forecast of 1.2 per cent growth in the Eurozone this year and predicted its economy would grow 1.8 per cent next year, a slight increase on February's forecasts.

"The recovery has now taken hold," said Siim Kallas, a European Commission vice-president who is overseeing the Brussels economic portfolio while Olli Rehn, the economic commissioner, takes leave to run for the European parliament. "Continued reform efforts by member states and the EU itself are paying off."

Although the European Commission data on inflation and growth will be closely scrutinised, the quarterly Brussels forecasts are most closely watched in national capitals for their predictions on budget deficits. The Commission's economic directorate now has the authority to punish Eurozone member states that fail to hit EU debt and deficit targets and it uses its own forecasts to draw such conclusions.

The new data could be particularly problematic for Francois Hollande, the French president, and his new prime minister, Manuel Valls, who are struggling to increase economic growth and employment amid growing voter anger towards the government. Recent polls show the governing Socialists finishing third in this month's European Parliament elections, behind the far-right National Front and the centre-right UMP.

Although Brussels sees Paris' budget picture improving, it still forecasts Mr Hollande's government will fail to get its deficit below the EU threshold of 3 per cent of economic output by next year, as it has promised. European Commission data says the deficit will stand at 3.4 per cent in 2015, requiring Mr Valls to find new austerity measures to hit the target. Still, that is an improvement from the 3.9 per cent deficit predicted in February.

Similarly, the Spanish government continues to see its budget deficit grow despite its promise to hit the 3 per cent figure in 2016. This year, Madrid's deficit is projected to hit 5.6 per cent, then grow again to 6.1 per cent next year. Although this is an improvement from the February forecasts, it still presents a major hurdle for the government of Mariano Rajoy, the prime minister.

Despite the improving economic and employment picture, Eurozone sovereign debt is expected continue to rise this year despite four years of concerted austerity measures aimed at bringing down government indebtedness. In 2014, sovereign debt is projected to hit a euro-era high of 96 per cent of gross domestic product before falling next year for the first time since the outset of the crisis, to 95.4 per cent.

Greece will remain the most indebted Eurozone country this year, with its national debt projected to hit 177.2 per cent of GDP.

Italy's debt will also continue to rise, to 135.2 per cent, second in the Eurozone, an issue of conflict between Brussels and the new government of Matteo Renzi, which is seeking an easier path to debt reduction. Italy will remain below the 3 per cent deficit cap this year and next year, the forecasts predict, but Brussels has demanded Rome cut its debt levels more quickly.

After Italy, the most indebted Eurozone countries for 2014 are forecast to be Portugal (126.7 per cent); Cyprus (122.2 per cent) and Ireland (121 per cent). Despite the high debt levels, Ireland exited its three-year bailout last year and has been able to raise cash on the bond market at record-low rates. In addition, Portugal on Sunday also announced it would leave its three-year programme in mid-May without further international assistance, a decision helped by its ongoing ability to raise funds cheaply in the private credit markets.